Catalent Inc (CTLT) 2016 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Catalent, Inc. second-quarter FY16 earnings conference call.

(Operator Instructions)

As a reminder, this call is being recorded.

I would now like to turn the conference over to Tom Castellano, Vice President Finance, Investor Relations and Treasurer. Please begin.

Thank you, Latoya.

Good afternoon, everyone, and thank you for joining us today to review Catalent's second-quarter FY16 financial results. Please see our agenda on slide 2 of our accompanying presentation, which is available on our investor relations website. Joining me today representing Catalent are John Chiminski, President and Chief Executive Officer; Matt Walsh, Executive Vice President and Chief Financial Officer; and Cornell Stamoran, Vice President of Strategy.

During our call today, management will make forward-looking statements, including its beliefs and expectations about the Company's future results. It is possible that the actual results could differ from management's expectations. We refer you to slide 3 for more details.

Please beware that the forward-looking statements are based on the best available information to management, and assumptions that management believes are reasonable. Such statements are not intended to be a representation of future results, and are subject to risks and uncertainties. We refer you to Catalent's Form 10-K filed with the SEC on September 2, 2015, for more detailed information on the risks and uncertainties that have a direct bearing on the Company's operating results, performance and financial condition.

As discussed on slides 4 and 5, on the call today we will also disclose certain non-GAAP financial measures, which we use as supplemental measures of performance. We believe these measures provide useful information to investors in evaluating Catalent's operations, period over period.

For each non-GAAP financial measure that we use on this call, we have included in our earnings press release, issued just a short while ago, a reconciliation of the non-GAAP financial measure to the most directly comparable GAAP financial measure. Please note that the non-GAAP financial measures have limitations as analytical tools, and they should not be considered in isolation, or as a substitute for, our financial results prepared in accordance with GAAP.

Now I would like to turn the call over to President and Chief Executive Officer John Chiminski.

Thanks, Tom, and welcome, everyone, to our earnings call.

We had good financial and operating performance during the second quarter, despite our situation in Beinheim. As you can see on slide 6, our revenue increased 6% in constant currency to $454.9 million, which includes organic growth of 5% compared to the second quarter of the prior year.

Top-line performance of all three of our reporting segments improved during the quarter, led by double-digit growth in the Development and Clinical Services segment. Also, Development and Clinical Services delivered a very strong 58% EBITDA increase compared to the prior-year period.

Our adjusted EBITDA totaled $101.1 million, which was below the second-quarter FY15, primarily due to the Beinheim suspension. Our adjusted net income was $44.9 million, or $0.36 per diluted share.

Before discussing our key accomplishments for the second quarter, I wanted to provide an update on our Beinheim facility suspension, which is 1 of 11 Softgel facilities in our worldwide manufacturing network of 31 sites. As we've previously disclosed on November 13, 2015, our Softgel manufacturing facility located in Beinheim, France, received a notification from the ANSM, the French pharmaceutical regulatory agency, suspending manufacturing at the site.

The suspension was precipitated by a series of incidents within the facility involving out-of-place capsules. Catalent had detected these out-of-place capsules within our facility over the course of several months, with a spike in July that led to the facility conducting a global risk assessment and implementing enhanced security measures.

However, we received notice on November 3 indicating a customer had detected an out-of-place capsule within its facility during its pre-market packaging quality assurance process. To date, there has been no indication of any detection in the market. As we previously disclosed, Catalent has filed a criminal complaint regarding these incidents.

The ANSM Issued its Notice of Suspension as a precautionary measure. They expressed concern with the out-of-place capsule incidents, and the potential for a malicious actor within the facility who might engage in action beyond out-of-place capsules. The ANSM is also concerned with the transparency of the classifications of the incidents within Catalent's quality management system, and the need for further involvement of our customers and the ANSM in further risk assessments.

In accordance with our standard continuous process improvement and quality management deviation review systems, facility quality personnel conducted risk assessments of these incidents, including the reassessment and reinspection of batches produced during the periods in which these incidents occurred. In addition, our customers whose products are made at Beinheim have conducted risk assessments in light of these matters, and have recalled some of the products produced in this period.

Following the initial concentration of incidents, we began to implement significant additional security and access control measures to limit access to products, and have further strengthened these measures since the suspension. Additionally, we proposed an overall restart plan, and worked with several customers on becoming eligible for the exemption process, with several applications currently pending. We believe we have formulated and are now implementing the right measures to prevent any further occurrence.

We've been working diligently with all relevant authorities in order to resolve the issues that led to the suspension as quickly as possible. On December 18, we met with the ANSM and committed to engage in further discussions for development of a restart process following prioritized protocols between our Beinheim facility and our customers. At the end of December, the ANSM approved production of a simulation, or placebo, batch so that we could test our new procedures in a production environment.

Additionally, we've recently reached another milestone with an ANSM inspection that is a prerequisite to the initiation of individual restart processes with prioritized customers under ANSM-approved exemptions. We currently expect that the facility will be fully operational by mid-March.

Matt will provide more specifics on the financial impact of the suspension later in the presentation, but I wanted to take this opportunity to provide additional clarity on the situation. As we've done from the outset, we will continue to fully cooperate with the ANSM and work with law enforcement officials on the ongoing criminal investigations.

Now moving to our key operating accomplishments, in the middle of January we announced a research collaboration with Roche to develop next-generation molecules using our proprietary SMARTag technology. Roche will gain non-exclusive access to our SMARTag platform, and will have an option to take commercial licenses to develop molecules directed to a defined number of targets.

It will permit the evaluation of alternative sites of drug conjugation so that Roche may develop molecules optimized for efficacy, safety and stability. The agreement included an upfront license fee of $1 million, which was recognized in the second quarter, and has the potential for $618 million in development and commercial milestones if Roche pursues commercial licenses and all options are exercised.

Also, at the beginning of December we entered into an exclusive long-term supply agreement to produce Pfizer's leading over-the-counter heartburn treatment, Nexium 24HR, also marketed as Nexium Control outside the United States. Nexium is one of the leading global OTC medicines, and its manufacture is well suited to our recently expanded Winchester facility where we have both capacity and flexibility to accommodate programs of this scale.

We are proud to partner with Pfizer in delivering this important product to patients worldwide. And this is another example of the traction we're gaining in our Consumer Health Initiative.

In conclusion, we're pleased with the performance of our base business during the quarter, despite challenges from our Beinheim facility suspension. The dynamics of our industry and market remain very favorable, and we continue to leverage our market-leading position, broad capabilities, global reach and regulatory track record to further penetrate our existing markets.

Now I'd like to turn the call over to our Executive Vice President and Chief Financial Officer, Matt Walsh.

Thanks, John.

I'll start my presentation with a brief review of our second-quarter operating accomplishments by reporting segment, starting with Oral Technologies on slide 7. Our Softgel business, which accounted for approximately 70% of Oral Technologies segment revenue, posted double-digit growth in both revenue and EBITDA on a constant-currency basis, excluding the impact of the Beinheim facility suspension.

More specifically, Beinheim reduced Softgel's expected top line by $21 million and EBITDA by $14 million. The EBITDA impact included one-time costs of $4 million. I have more specifics to share on Beinheim momentarily.

Elsewhere across our global Softgel business, our Consumer Health Initiative is gaining traction within Latin America, Asia Pacific and Europe. Additionally, we see continued strength in North America, driven by development revenue and our Rx product slate. Due to these positive trends, we believe the Softgel business, excluding Beinheim, is positioned well for profitable growth throughout the remainder of the fiscal year at a level nicely above recent trend lines.

The Modified Release business, which accounted for roughly 30% of Oral Technologies sales, had another challenging quarter, as we expected and discussed during the last earnings call. Due to lower customer demand for certain higher-margin products, revenue within controlled release declined year over year, and EBITDA margin was affected by unfavorable product mix.

Overall though, the Modified Release business fundamentals remain strong. However, we do expect the business to continue to be challenged throughout the remainder of this fiscal year.

Now let me provide you with an update on the financial impact of the Beinheim suspension, as outlined on slide 8, to both our fiscal second quarter and to the full year as we see it today. We have separated out the one-time costs in the second quarter from the continuing operations impact for transparency.

The full-year estimated impact assumes that the site is fully operational by mid-March, with progressive restart of certain individual products prior to that. For absolute clarity, the figures on this chart represent the change in financial performance as compared to the Company's previously issued guidance, last affirmed November 3, 2015.

Now moving on, our Development and Clinical Services segment, shown on slide 9, posted strong organic growth during the second quarter. The good performance of the Clinical Services business was attributable to the increased customer project activity and comparator sourcing activities. Revenue and EBITDA growth, as well as margin expansion in the Analytical Services business, was driven by our integrated oral solids development and manufacturing business based in Kansas City.

Additionally, a one-time volume commitment resolution within the segment's Development and Analytical Services business increased the segment's revenue and EBITDA by $10 million. Our recent Micron Technologies acquisition also contributed modestly to segment performance during the second quarter.

As of December 31, 2015, our backlog for the Development and Clinical Services segment was $433.8 million, a 2% sequential increase. The segment also recorded net new business wins of $133.8 million during the second quarter, representing a 33% increase year over year. The segment's trailing-12-month book-to-bill ratio was 1.1.

Now on slide 10, turning to the Medication Delivery Solutions segment, our Blow-Fill-Seal offering continued its strong underlying performance, with the core business posting double-digit revenue and EBITDA growth during the second quarter. However, a one-time volume commitment resolution recorded in the prior year negatively affected year-on-year growth. Market fundamentals for Blow-Fill-Seal remain attractive, with a robust new product pipeline and continued (technical difficulties).

Ladies and gentlemen, please stand by. Your call will resume momentarily. Once again, please stand by. Your call will resume momentarily. Thank you.

You may resume your conference.

Okay. Thank you, operator.

Ladies and gentlemen, I apologize for the technical difficulty. We will back up the program to where I started to talk about slide 10 that is entitled Medication Delivery Solutions Segment Update.

Our Blow-Fill-Seal offering continued its strong underlying performance, with the core business posting double-digit revenue and EBITDA growth during the second quarter. However, a one-time volume commitment resolution recorded in the prior year negatively affected year-on-year growth. Market fundamentals for Blow-Fill-Seal remain attractive, with a robust new product pipeline and continued product mix shift to higher-margin products.

The Sterile Injectables business experienced a modest decline in revenue during the second quarter, although EBITDA improved over the prior year due to more favorable product mix. While our expectations in this business for the rest of the year remain muted, we believe that our entry into the animal health market positions us well for future growth in FY17 and beyond.

Finally, our Biologics business performed well, and continues to be the fastest growing business within the Company, as recent investments continue to pay off. We saw growth within our Madison facility, which was driven by the completion of project milestones.

Additionally, during the second quarter we recorded a $1 million license fee from Roche, as John alluded to earlier, which signed a multi-milestone license and development agreement for our SMARTag ADC linker technology. SMARTag continues to meet proof-of-concept milestones, and customer interest remains strong, with the research collaboration with Roche being the most visible recent development. We continue to believe that our Biologics business is well positioned for future growth.

Once again, and in order to provide additional insight into our long-cycle business, which includes both Oral Technologies and Medication Delivery Solutions, we are disclosing our long-cycle development revenue and the number of new product introductions. As a reminder, these metrics are only directional indicators of our Business, since we do not control the sales or marketing of these products, nor can we predict the ultimate commercial success of them. We do, however, expect these metrics to offer insight into the long-term organic growth potential of our long-cycle business.

Due to the inherent quarterly variability of these metrics, we will provide the numbers on a year-to-date basis. For the six months ended December 31, 2015, we introduced 86 new products, which is level with the number of new products launched in the same period of the prior year. Also, in the same year-to-date period, we recorded development revenue of $73 million, an increase of 20% versus the same period of the prior year. As a reminder, the number of NPIs in any given period depends on the timing of our customers' product launches, which are often driven by regulatory body approvals or are otherwise at the discretion of our customers, and thus this figure will continue to vary quarter to quarter.

I will now provide more details on our financial results for the second quarter. As a reminder, all of the segment revenue and EBITDA year-over-year variances I will discuss on the next few slides are at constant currency.

Turning to slide 11, revenue from the Oral Technologies segment was $255.1 million for the second quarter, increased nominally versus the second quarter a year ago. This performance was attributable to the temporary suspension of operations at our facility in Beinheim, softer demand for certain higher-margin offerings within our modified release technologies business, and lower revenue from product participation-related activities, offset by increased demand overall for Softgel.

Oral Technologies segment EBITDA for the second quarter was $59.1 million, a decrease of 16% versus the second quarter a year ago. The decrease was primarily attributable to the temporary suspension of operations at Beinheim, as well as to lower demand for certain higher-margin offerings within modified release technologies. This was partially offset by higher sales and more effective absorption of fixed costs through higher capacity utilization at our other Softgel sites.

Revenue from the Development and Clinical Services segment was $131.6 million for the second quarter of FY16, an increase of 24% over the second quarter a year ago. This increase was primarily attributable to strong organic growth in our analytical services and clinical services offerings, as well as to the revenue contribution from the Micron acquisition and a volume commitment resolution.

Development and Clinical Services segment EBITDA for the second quarter was $34 million, an increase of 58% year over year. This strong EBITDA improvement was primarily driven by increased sales across the segment, the timing of resolution of volume commitments, and contributions from the Micron acquisition.

Revenue from the Medication Delivery Solutions segment was $71.1 million for the second quarter, an increase of 1% over the second quarter a year ago. This growth was primarily due to increased demand for our biologics offering and products utilizing our Blow-Fill-Seal technology platform, partially offset by a decrease in revenue due to the timing of resolution of volume commitments with respect to the Blow-Fill-Seal platform and decreased demand for injectable products at our European pre-filled syringe operations.

Medication Delivery Solutions segment EBITDA was $17.2 million, a decrease of 2% over the prior-year period. This decrease was primarily attributable to the timing of resolution of volume commitments with respect to products utilizing our Blow-Fill-Seal technology, partially offset by increased profit generated by higher revenue from our biologics offerings and favorable revenue mix shift from our injectable products within pre-filled syringe.

Turning to slide 12, we see, in precisely the same format as on slide 11, the six-month year-to-date performance of our operating segments, both as reported and in constant currency. I won't cover every variance item in detail, but I will say that our year-to-date top-line results parallel our second-quarter results [which show constant-currency] revenue improvement and similar EBITDA performance across all three reporting segments. The year-to-date 8% constant-currency revenue growth, or 7% growth on an organic basis, compared to the same period a year ago, was modestly above our long-term objective of 4% to 6% organic revenue growth per year.

Slide 13 shows the reconciliation to the last 12 months EBITDA from continuing operations from the most proximate GAAP measure, which is earnings from continuing operations. This is a mechanical computation which doesn't require much supporting commentary. It is included there for your benefit to assist in tying out the reported figures to our computation of adjusted EBITDA, which is detailed on the next slide.

Now looking to adjusted EBITDA on slide 14, second-quarter 2016 adjusted EBITDA decreased 10.5% to $101.1 million, compared to $112.9 million for the second quarter a year ago. Excluding the impact of FX translation, our second-quarter adjusted EBITDA declined 7.1% to $104.9 million, as higher profitability in Development and Clinical Services segment was offset by a decline in the Oral Technologies and Medication Delivery Solutions segments.

On slide 15, you can see that second-quarter adjusted net income was $44.9 million, or $0.36 per diluted share, compared to adjusted net income of $55.9 million, or $0.44 per diluted share in the second quarter a year ago. This slide also includes the reconciliation of earnings from continuing operations to non-GAAP adjusted net income in a summarized format for your reference. A more detailed version of this reconciliation can be found in our supplemental information section of the slide deck, where you will find essentially the same add-backs as seen on the adjusted EBITDA reconciliation slide.

Now turning to slide 16, as of December 31, 2015, our leverage ratio was 4.1 compared to 3.9 as of June 30, 2015. And our [debt] capital structure was essentially unchanged during the second quarter.

On slide 17, we detail our revised FY16 guidance, which we are lowering due to the Beinheim suspension. We expect to incur further adverse impact from foreign exchange translation [impact], which we believe will be offset by growth in the base business, which is modestly above our prior guidance.

For FY16, we now expect revenue in the range of $1.78 billion to $1.84 billion, compared to the previous range of $1.81 billion to $1.9 billion. We now expect adjusted EBITDA in the range of $410 million to $435 million, compared to the previous range of $434 million to $457 million. Adjusted net income is now expected in the range of $185 million to $205 million, compared to the previous range of $203 million to $226 million.

We continue to expect capital expenditures in the range of $125 million to $135 million. Our fully diluted share count on a weighted average basis for the fiscal year ending June 30, 2016, is now expected to be in the range of 125 million to 127 million shares, compared to the previous range of 126 million to 128 million shares.

It's important to note that the revenue and adjusted EBITDA ranges to which we are guiding are consistent with our constant-currency long-term outlook of 4% to 6% organic revenue growth and 6% to 8% organic adjusted EBITDA growth, excluding the impact from the Beinheim facility suspension.

We also wanted to take this opportunity to provide clarity related to two components of adjusted net income: interest expense and cash taxes. We expect our interest expense for the third and fourth quarters of FY16 to be closely aligned with what we reported in the second quarter. Related to cash taxes, we expect the full-year figure to be in the range of $40 million to $46 million, incurred approximately linearly across the quarters.

Slide 18 bridges our FY15 results to our revised FY16 guidance. As you can see, we expect that the negative impact from foreign exchange translation will be offset by solid performance of our base business, which remains strong and is growing in line with our long-term outlook on a constant-currency basis, leads to the change in guidance really being driven by the Beinheim temporary suspension.

Lastly, let me remind everyone of the seasonality in our Business, and highlight our expected quarterly progression throughout the year. Due to the timing of our customers' annual facility maintenance periods, as well as the seasonality associated with budgetary spending decisions in the pharmaceutical and biotechnology industries, the first quarter of any fiscal year is generally our lightest of the year by far, with the fourth quarter of any fiscal year generally being our strongest by far, with this trend being slightly more pronounced during FY16 as compared to recent history. Therefore, as a result of the Beinheim facility suspension, we expect the ramp-up in profitability from our fiscal third quarter to our fiscal fourth quarter to be more amplified than what we have experienced in prior fiscal years.

Operator, I'd now like to open the call for questions.

(Operator Instructions)

Ricky Goldwasser, Morgan Stanley.

This is Mark Rosenblum in for Ricky. Just on the -- I'm looking at slide 18 on your deck. On the ranges here, can you give a little more detail on what the assumptions for the plant opening backup is from the bottom to the top of the range? And then also the same thing on the FX impact?

We expect the facility to be fully operational by mid-March with selected products coming up before then. Really, any difference between the bottom and the top in the range would just be driven by the timing of the re-onboarding of those product, whether they are before full reinstatement operations or after.

Got it, okay. Then on the profitability, it looks like the 2Q impact implies a [56%] margin on those products. Are the softgel products that are in that facility higher margin? How should we think of them compared to the overall business?

The overall business at Beinheim is pretty consistent with the rest of the network. I would discourage you from looking at these numbers as being representative of somehow the average profitability, because these numbers contain all of the costs associated with remediation activities during the suspension period. It will make it look like these facilities -- these products are more profitable than they are.

Tycho Patterson, JPMorgan -- Peterson, sorry.

Can you maybe just touch on customer retention around Beinheim? Did you lose any key customers with regard to the closure?

Hi, Tycho. John here. What I would say is that many of these products at this facility are single source, sole-source products for Catalent. We're working with those customers directly in terms of submitting what are called global restart plans. And then working with our customers to go ahead and restart those products. So there is no, I would say, significant customer retention issue at the site with regards to the -- broadly speaking for the product slate that we have there.

Okay. And then on Redwood, it is good to hear about the Roche collaboration. Can you maybe talk to general interest in this technology and whether there is an [impact of business building] up there?

As you know, this is a new technology, second-generation technology with regards to our conjugation (technical difficulties) technology. It's for the ADC. And I would say we had a very strong interest prior to Roche where we have many high-valued customers that we're not disclosing, just because of agreements that we have with them. And then obviously post the Roche agreement, I would say we've had an even heightened awareness of both the technology, as well as interest.

I think it is really proceeding as we have expected. And as we continue to do proof-of-concept it's continuing to meet all of those milestones. I would just say we're very much on track for this technology.

On capital deployment, you guys have been open about your desire to do M&A. Obviously with the market volatility, valuations have come in a bit. Are you looking more aggressively at opportunities? Are you seeing more come across your desk? What is the likelihood you get something done here?

What I would just say is that our funnel continues to be very robust. And I would say it is independent of current market, or as you call it, valuations. I would say we are just as active, if not more active, than we have been over the last couple of years. And that is because we have been aggressively pursuing things for a while. We hope that in the next 12 to 24 months we will see a better fruition of what's built up into that funnel, but still remain very active, and I would say independent of current market valuations.

Derik de Bruin, Merrill Lynch.

What was the Micron contribution to the quarter?

Micron contributed less than 1% of the quarter's sales.

Great, thank you. I guess, what is the risk to the March restart? Could this drag on for another couple of quarters? What is your confidence level around having the restart?

What I would tell you is that based on the productive, collaborative and constructive meetings that we have had with the ANSM that started in December, which I highlighted in my earnings release, I would say that they have given us significant clarity and a road map to what we needed to do to restart the facility, which gives us the current confidence that we have in the mid-March start. We have also built into there some contingencies based upon an additional inspection that will need to happen. And [when we will respond], certainly I'd have to say this is all contingent upon the regulatory body, the ANSM specifically.

But at this point we have very strong clarity about what we need to do to restart the facility. It starts with doing three customer restarts that we have visibility to start within the next week or so. And then following that, an inspection. We should have visibility to starting in that March timeframe.

I do not think we are off by significant numbers. If we are, it is certainly would have an impact. But I would say the clarity that we have right now provides us a high degree of certainty that we will be able to get the Beinheim issue behind us. And we're certainly in a different part -- different spot in terms of certainty and clarity than we were sitting in November and December.

Are the regulators confident that -- it sounds like this was a malicious act. And they are confident that this isn't like a general breakdown of your processes. And they are comfortable with the idea that somebody -- well, I don't know if comfortable is the right word, but they agree with you that this is not (technical difficulties) a broader process. It's a particular individual or individuals who are causing the problem?

Yes. What I would tell you is that the malicious act precipitated the ANSM's action. Certainly they have found other areas where they wanted us to make improvements in both how we alert the authorities to these type of acts, how we assess our -- what levels assess specific deviations and corrective actions and so forth.

We are well on our way to satisfying the ANSM's concern. They're, I would say, motivated to assist us in getting started. And again, they have told us that it is in Catalent's hands now to get this moving forward. So we have a high degree of clarity to do that.

Great. Just one final question. Are you liable to any of your customers, [is there] any product liability issues? Do you have to worry about any legal actions, anything like that to come back and bite?

In terms of that, Derik, we've got, I think, two things to discuss. First of all, all of the key products at the site are under contract. The contract provisions include limitations of liability, which is Catalent's standard across our network. That is one layer of protection, if you will. We also have insurance coverage. So we believe the (technical difficulties) will enable us (technical difficulties) the type of exposure you are referring to.

Dave Windley, Jefferies.

On Development and Clinical Solutions, the volume commitment resolution seemed relatively large. And I guess I was interested, Matt, in your describing to us, maybe you have those on a regular basis and we don't know about them.

So what is typical, what is average in a quarter for you to see in terms of these commitment resolutions? And was this $10 million that you are calling out, was that essentially $10 million in revenue that falls straight through to EBITDA, how should I think about that?

To answer the last part of your question first, it is $10 million of revenue that falls directly through to EBITDA. I would say that these resolution of volume commitments are small in number. They are not a typical part of our business.

We had, I think, three such instances in the prior fiscal year and one so far in this fiscal year. And I would tell you three would be on the high side for expectations. We don't ever include those kinds of things in our guidance, for example. That just gives you a feel for management's view of the predictability, or number of these things.

Why the number seems large is just related to the specifics around that certain product. When the contract got signed, our customer had very rosy projections about what the product would do in the marketplace. And that underpinned what minimums were in the contract.

The product is selling. It is a viable product. Sales are increasing. But they are just not near the level that was contemplated by the customer when the contract was signed. In circumstances like that, customers will typically ask for relief from the minimums, which we are willing to do as long as we are able to guarantee our return on capital.

In this case, we effectively accelerated certain payments that would have otherwise been due under the contract, such that we are able to guarantee our return on capital that we deploy. But in the same way give the customer some added breathing room on their end. These amendments, when we do them, are typically win/wins. And that is what it was in this case.

Okay. You answered my next question already, then. Moving on, sticking with DCS, the revenue growth there is very impressive, kind of carried the quarter from a growth standpoint on both revenue and EBITDA. Your backlog increased 2% sequentially. I'm interested in how we should think about duration and conversion of that backlog into revenue? Clearly, obviously the $10 million you just described had an influence on growth rate, but how should we think about what current backlog can sustain in terms of DCS growth rate?

The way to think about backlog in this business is, generally when we book new business it will generally start sometime in the next three to six months, sometimes longer. And then the average project may run in quarters, in terms of its overall duration.

The results that we're seeing, we think will sustain good growth for the foreseeable future in the (technical difficulties) business. And the good part about it was we saw it across our clinical supply business as well as our analytical business, and the return to growth. Growth that we believe is more indicative of the baseline growth of the clinical services business, was really good to see and it was a payoff from reorganizational activities we had undertaken to strengthen the focus of our business development efforts in Europe.

Okay. I wanted to ask one more, if I could. And that is going to Oral Technologies, you've talked for some time about Consumer Health Initiative, and that driving mix shift toward consumer.

In your prepared remarks, you called out strength in North America driven by development and the prescription products slate. So I guess I struggle. It feels like a little bit of intellectual [lip size], I suppose, in terms of trying to figure out which way is that business really headed and what is driving the performance? Thanks.

Within our softgel business, the Consumer Health Initiative is something that we have been operationalizing and planning for, and it is coming to fruition as we had planned. By the end of the fourth quarter we will have probably ramped up most or all of the volume that we had anticipated in that initiative. Really everything is on track as far as that is concerned.

We have seen relatively better performance than we had expected when the year started out of our prescription business in North America, both in terms of commercial sales as well as development revenue. These things, when they happen in the actuals, we're talking about them as drivers because they are drivers, David.

It explains why the softgel business is not only up in sales, but it's margins have -- not only have they not declined as the Consumer Health Initiative ramps up, but they have actually gone up. Softgels, excluding Beinheim, is having a very strong year.

John Kreger, William Blair.

Matt, in terms of the Beinheim remediation plan that it sounds like is very much in place, does any of that include changes to your broader global manufacturing footprint? And if so, is that in your guidance at this point?

No changes to the global footprint contemplated, but everything that we know about the current situation of Beinheim is encapsulated in our guidance. That includes the ramp-up to full restart and a lot of the catch-up work from, let's say, excess of orders that have been delayed to be filled, Beinheim will be actively filling those in the fourth quarter. We've reflected that.

We are also accounting for some additional costs that we will be taking on to make sure that we have business continuity planning in terms of second-sourcing within Catalent softgel network, any products that our customers would like to have a second source within the Catalent network. All of those costs and everything that we know is encapsulated in the current guidance.

Great, thank you. Another guidance question. You gave us CapEx for the year. Could you comment maybe a little bit more broadly about what your cash flow expectations are, either operating or free cash flow for the year?

That is not guidance that we provide, John. But I think we have certainly giving you the components to be able to develop that. And if you would like to have more conversation on that, that is something that maybe we can handle offline. But the Company doesn't provide guidance to cash flow, but the pieces are there.

Okay. One last one. Now that you've got the Roche collaboration for in place for Redwood, can you talk a little bit more broadly about when we can expect that to start to ramp? I would assume that collaboration in particular is probably a multi-year in terms of your ability to secure any of those milestones. But maybe a little bit more broadly, what is the pace at which that turns into becoming a nice revenue driver for you?

The timing of that really depends on the research and development efforts of Roche, which is just very difficult for us to pin down. That is a challenging question for us to answer, John. I can tell you there is nothing significant in the current guidance for it. And it is the kind of time line that I would say spans years versus quarters.

Great. Would you expect other similar collaborations to happen in the coming year or two?

We definitely do. And sort of virtuous cycle, the announcement of the Roche deal, John mentioned, has generated even more interest in the technology, which is a nice outcome.

(Operator Instructions)

Tim Evans, Wells Fargo Securities.

I also wanted to touch on the Roche deal. Just thinking maybe into 2017, FY17 a little bit, how would you handicap the probability of receiving milestones in that year? And I guess maybe a better way to ask it in terms of getting at how we might model this is, how lumpy or how large are any -- could any individual milestones be on a quarterly basis?

This is John. Let me answer from the standpoint at when you think about this kind of a development agreement with Roche, this is basically starting out at the very beginning of their research and development in terms of how to properly conjugate different molecules, if you will, and move them forward.

When we take a look at a development agreement like this, this is going to have, think of it is a 5- to 7-year type of agreement where the initial revenues that we're going to be receiving are going to be on the development front with them more so than, I would say, on the milestone front. That is probably as much as I would probably say at this point.

Certainly we're looking to sign other deals of this nature because they end up having an overall layering affect, if you will, in terms of the overall technology. And I will also just remind you and the folks that from a biologic standpoint we really see this as a piece of our overall biologic strategy within the Company to really improve our overall relevance within the space, since biologics is going to be such an important part of our future.

Okay. With that in mind, how do you envision the longer-term growth rate of the Dev Clin segment at this point?

The biologics business is a part of our Medication Delivery Solutions segment, Tim, just to make sure that we are all aligned on that. Right now, biologics today is approximately 15% to 20% of the sales of that segment.

It is growing double digits. And we believe can continue to grow at that pace. So it will be a strong contributor to the growth at the MDS segment overall.

Sean Wieland, Piper Jaffray.

Another one on the Beinheim facility. Just wanted to get my head wrapped around potential liability here, still. I realize you haven't seen any out-of-place capsules within the marketplace. How confident are you that you won't?

This is John here. What I would just say is that the initial out-of-place capsules occurred in the July timeframe of last year. And we are now talking seven months, six or seven months displaced from that, and we've only had one capsule that was detected at our customer's packaging -- (technical difficulties) processes caught it up.

What I would say is the amount of time that has gone by and the number of batches that were put out into the field gives us a high degree of confidence. But that being said, we are not 100% certain. But there is enough signals here that make us very comfortable.

And I would also say in terms of there were some initial batches that were recalled from a large number of batches that were produced during the timeframe that the ANSM was concerned with. From the initial suspension where we had some initial recall activity to now, that recall activity has dwindled to basically zero over the last 3 to 4 (technical difficulties).

In terms of the assessments of our customers and our own assessments, along with the fact that we've had no detection in the marketplace, gives us a fair degree of certainty. And then as I said, the ANSM has provided us some very strong clarity around restart on (technical difficulties) and they (technical difficulties) for us to do that.

We have our first (technical difficulties) I would say, kind of approved restart plans. And we have some good clarity. So overall, that is, I think, a good assessment of, do we expect to see one out in the marketplace? I think that the data speaks for itself.

With regards to the liability question, again Matt had talked both about the fact that all of these products are under contracts where we do have limited liability baked into them. We also have insurance, and any claims that have been logged already have been reserved and are in our current guidance.

How many batches were recalled?

We're not reporting the number of patches that were recalled. I would say it is a small number compared to the overall number that have been produced at that time period. As I said, and nothing recent over the last three or four weeks.

Okay. And do you have -- you said that you have had claims presented against the Company for losses. What is the total value of the claims that have been presented so far?

We are not disclosing that, Sean, but it is currently reflected in our second-quarter actuals. And that's -- and anything that we know of is -- in the future is already encapsulated in our guidance.

All right. That was my next question, when do you account for it. So you account for it as soon as you get a claim?

Correct.

(Operator Instructions)

There are no further questions at this time. I will turn the call back over to John Chiminski for closing remarks.

Actually, this is Tom. Before we turn it over to John, I just want to apologize for the technical difficulties. Given them, we've posted a copy of our prepared remarks on the investor section of our Catalent.com website for analysts and investors to go in and pick up.

Thanks, Tom. In conclusion I would like to reiterate that we are pleased with the underlying trends in our base business during the second quarter, and we look forward to building on that momentum in the coming quarters.

The market for advanced (technical difficulties) technologies and (technical difficulties) remains globally robust. We remain focused on the Beinheim remediation, capitalizing on our industry-leading partnerships, and returning to our long-term growth outlook of 4% to 6% organic revenue growth and 6% to 8% organic EBITDA growth during FY17.

I would like to thank all of you for joining us today. We look forward to updating you again on our next conference call. Thank you.

Thank you, ladies and gentlemen. This concludes today's conference. You may now disconnect. Good day.